Tuesday, December 23, 2008

Is Going Local an Alternative to Growth?

One of the reasons I became an economist was because of the precision it demanded. Other disciplines that I explored that addressed the issues I was interested in were too seduced, in my view, by the allure of good sounding ideas without any real evidence or theoretical underpinning suggesting that they would be effective. Economics is, for some, too rigid for those same reasons, but I appreciated the disciplined thinking economics demanded. Today, in an opinion piece in the Oregonian is a good example of the kind of sloppy thinking and nice-sounding idea that does not survive real scrutiny in economics. Unfortunately, I think we are going to see a lot of this type of rhetoric in these troubled economic times.

Seth Walker in his earnest opinion piece discusses the plight of an educated but unemployed homeless couple. He claims that 'flawed economic theory' in the form of 'free market economics' was the cause of their plight and the current economic crisis. Their jobs were, apparently, victims of downsizing and there is a suggestion that globalization and outsourcing could be to blame. His answer? Investing in local business, but not just local, business that do business with other local businesses.

Now, let me pause here and say that the idea that local businesses should strengthen local ties, source locally when possible, and reinvest locally are all fine. I have no problem with this idea, nor do I have a problem with the similar idea of local currency. These efforts can have marginally beneficial effects on local businesses and to the extent that we care about eating locally and the like, it can lead to increased consumer surplus. But please don't sell these ideas as something they are not, and they are certainly not an alternative to market based growth strategies. [The piece is a little confused, by the way, talking alternately about not focusing on growth but suggesting that investing locally is the way to economic security]

There are two big problems with this line of argument. The first is that growth comes from investment and productivity and this strategy offers neither. The second is that without growth it is virtually impossible to to focus on the "other factors" he identifies such as social benefit and environmental well-being.

The idea that if everyone were to concentrate on local investment we can make the local economy better is simply wishful thinking. This is not net new investment in the local economy, just a shift in investment capital (assuming everyone everywhere took his advice) and it represents investments in an ideal (localism) that presumably would lead to lower returns - since efficiencies from comparative advantage would be sacrificed. Thus the return on these investments would be lower, future investment would be muted and so on. So the end result would be slower growth. There is also no reason to believe that this investment strategy would spur the development of new technology that would promote efficiency gains that could be growth promoting. In fact, if new capital is not chasing the best ideas wherever in the world they may be, there is good reason to believe this would stifle the development of new productivity enhancing technology.

The suggestion that we shift our focus away from economic growth to 'other factors' ignores the inconvenient truth that all of these other factors are inexorably linked to growth. Without increasing productivity and growth we have no way to combat serious issues such as global poverty, malnutrition, low life expectancy, political disintegration and the environmental degradation emanating from developing countries like China. With about one billion impoverished people in the world, I have to admit that as much as I like the idea of localism it is, for me, a second-order concern. It is also quite possibly harmful to the environment. Sourcing everything locally suggests that we need to make everything locally even if it is less efficient. Doing so would leave a larger carbon footprint.

So these nice sounding ideas are not much help to the unemployed couple mentioned in the piece, without growth where are their new jobs going to come from? Their story perhaps (if indeed their jobs were outsourced) is one of a lack of government provided retraining opportunities in response to the disruptions increased globalization can bring.

The ironic thing is that these ideas are not new. During the 70s and 80s many developing countries, such as Brazil and India, pursued a strategy of 'import substitution' where they tried to develop local industries to provide goods that were being imported from other countries. The results were disastrous. Growth stalled and these became lost decades for these countries with real and dire consequences for the millions of the resident poor. It was not until this strategy was abandoned that these countries have experienced the rapid growth that has allowed them to lead serious campaigns to eradicate poverty, address environmental degradation and the like.

Not all is rosy about the recent growth of these countries, Brazil, for example, is one of the most unequal countries in the world. So even though it is now considered a middle income country, it still have a massive poverty problem. So growth is not the end goal, you can have growth and still see little progress on the other dimensions, but it is the means by which you can achieve these goals.

While it is true that the current economic crisis has revealed some egregious flaws in the way we regulate the banking sector, and the unequal returns we have seen from the latest growth episode in the US is also a problem, to suggest that it has shown free market economics as a whole to be a failure is misguided. It is only by harnessing the power of markets that we can seriously hope to deal with the earths biggest challenges. The key is in becoming better at recognizing the limits of markets and addressing these limitations with appropriate policy. We need to embrace globalization and free trade but better manage the global economy so that we can tackle these problems - problems that are global, not local.

4 comments:

Well, once again an economist describes the world in ideal terms, rather than as it really is.

The key assumption in your entire post is contained in this parenthetical:

assuming everyone everywhere took his advice

But an op-ed by a local person in a local paper is NOT a call for everyone everywhere to take his advice, it's for everyone HERE to take his advice.

And under no circumstances can he possibly be seen to be arguing for a 100% pure application of his idea.

If everyone in Portland were to substantially boost their local buying and local sourcing, then, YES, we would see an improvement in the local economy.

By definition, if we keep more of our money at home, while maintaining our levels of capital in-flow from other regions, then we're going to see a net increase.

As a local business owner, I'm doing as much as I can to source locally - while also doing as much as I can to attract business from outside the region. The more successful I am, the more our economy benefits.

Portlanders do a lot of things differently than the rest of the country. There's no reason that we can't do more and do better on sourcing locally -- and the op-ed should be seen as a call to arms in that direction, rather than as some argument for a new global economic strategy.

(And yes, this is why I've alway seen macroeconomics as having only marginal value in real-world policy-making: The economics dudes always want to talk about pure and global systems, as theoretically applied rather than as actually applied in the real world.)

Yes, Professor Emerson, thanks for this post. I basically agree with you. Kari’s comments just show, at least on the Democratic side, that this is a significant issue, and one that may split the Democratic Party. In its larger dimensions, it is about the ongoing argument over what kind of restrictions we put on international trade.

There is nothing wrong with buying local, if the local products or services are the best value for what you want. And we certainly want to attract outside investments and keep investment local when we can. No arguments with that.

But the big danger is that we lose sight and contact with what is happening in the larger global economy, thus overtime becoming an economic backwater unable to compete with the products and services offered in the larger global economy. The global market is where the action is. Two, possibly three, billion new consumers are rising out of poverty to join a global middle class. We can sell goods and services to them. For Oregon to focus on selling to one another, or even regionally, rather than these new consumers is a long term economic disaster. This is practical economics. We cannot successfully return to the past. We must move on bravely to the future.

It is why we must significantly change our educational system to connect more robustly with the rest of the world. We must invigorate our world (foreign) language programs and send our high school students to study abroad in large numbers.

I agree that if capital inflows stayed the same there would be a net increase, but why would they? Since we need to have a special effort to keep investment local we are, by assumption, accepting a lower rate of return. If additional investment dollars in the local economy lowers the marginal return on investment, this should cause outside capital to leave to find higher returns elsewhere.

My point is precisely that you can't think in partial equilibrium (to use the economist's parlance) but you have to think about general equilibrium. And I would argue precisely the opposite: that macroeconomics makes us confront the harsh reality that we do not live in closed systems and that thinking of closed systems can lead us far astray.

I am not suggesting that this is not a worthy endeavor, but the opinion piece suggests that this is a way to solve local unemployment and it is not (or at least there is no good reason to think so).

Now, I think the best counter argument to me is to suggest that somehow increased local private investment might kick start the next great economic engine a la silicon valley. But to me this is really a public goods problem.

Anyway, thanks for your POV. Much appreciated. I anticipate that these debates will rage among Democrats for the next few years. So we shall probably have many more opportunities to discuss.

I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.

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